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Many have argued that we are entering a "New Era" for stocks. Typically, these arguments revolve around the baby boom saving for its retirement, and they often project 15% to 20% annual growth rates until 2007.
|"We're facing 25 years of prosperity, freedom, and a better
environment for the whole world."
it will mushroom into a very strong period of growth between
late 1998 and 2007 when the third and largest wave of baby boomers comes into its peak
spending and durable goods buying and the next generation of 25-year-olds simultaneously
enters its initial spurt of durable goods buying."
The Great Boom Ahead
|The bullish case for stocks was summarized in a Dow Jones Money Management
Alert interview with a well-established
portfolio manager. We have withheld the name. What is important is that he manages large
accounts ($500,000 minimum) and we believe his comments reflect the consensus view.
Some excerpts from the interview:
He's predicting a bull market for at least five years - 10 if conditions don't change dramatically.
"It's a wonderful time period that's going to last for a while," he says. "We won't experience anything like this again."
His prediction is based on the influence of Baby Boomers who continue to pour their incomes into mutual funds, which in turn drives up the prices of stocks. Xxxxxxxxxx expects the bull market to turn bearish when the Boomers begin drawing on those investments rather than adding to them.
Dow Jones Money Management Alert
As this chart shows so dramatically, July 1997 ended the first fifteen year period in history to experience 15% annual growth in stock prices. In fact, if you examine the entire period from January 1871 through August 1997 (preliminary average), the average annual growth rate was only 4.28% (upper horizontal line on the chart). The reality of the price action is that we have already experienced the effects of baby boom saving. There are sound demographic reasons for this.
|The charts and text on this page (and the linked pages) examine rates of return in the
stock market using data back to 1871. The results may be quite surprising.
This chart shows the 15 year growth rate of the S&P 500, using monthly average data. We have spliced the Cowles Commission average on so that we can show over a century of data (raw data starts in 1871, the first 15 year change is 1886). The growth is based on price appreciation only, dividends and inflation are not accounted for.
Is Inflation Distorting the Picture?
It could be argued that the the spectacular results of the last fifteen years are overstated by inflation, since the chart is based on current dollar stock prices. The next chart shows the same study based on the constant dollar S&P 500.
As both of these charts demonstrate, the U.S. stock market has experienced the largest growth rate in over a century during the last 15 years. The forecasters predicting 15% annual growth in stock prices until 2007 have their eyes firmly planted on the rear-view mirror. They're doing what most forecasters do extrapolating the most recent trend.
Some might argue that these charts are distorted by the time period chosen. After all, the 1982 low was 15 years ago. We have examined four shorter time periods (charts below) with similar results. They are summarized in this table:
July 1997 witnessed extremes in growth in all of these measures. The annual growth rate was over ten times average.
Notes: There are two other myths of conventional widsom that are challenged by this table.
The price data that we used starts in January 1871. That meant that the first 12 month growth rate that we could calculate was January 1872. The average 12 month growth rate in the table above is the anualized growth from January 1872 to August 1997 (using a preliminary monthly average).
Why these time periods?
After surveying these five periods of growth (ten charts), it is clear that we have experienced growth rates in stocks (both nominal and adjusted for inflation) that are so high as to be either unprecendented or very unusual.
New Era: Myth or Reality?
To assert that stock market growth will continue at present levels for the next ten years requires the belief in a New Era. There is simply no historical precedent for that assertion. In addition, the foundation of the arguments for a New Era for stocks rests on demographic arguments that we have found do not work. The Saver/Spender ratio (which has worked in the past and in Japan) argues that we have already seen the bulk of stock market growth due to demographics.
Are We There Yet?
This series of studies doesn't claim to be able to forecast what month the stock market will top. It does supply ample evidence that any sustained growth at these levels from here would be unprecedented. Records are made to be broken (witness the 15 year growth rates), but it happens rarely, and sustaining record-setting levels is even more rare. While we can't say that we are at a long-term top, the evidence suggests that we're getting very close.
Most of the demographic arguments for stocks as an investment assume that the first wave of baby boomers kids that's about to turn 25 is a positive influence for stocks. They're buying houses, cars, and paying for all the costs associated with children. The conventional wisdom is that all that spending fuels the economy, and results in rising stock prices.
We have found that the population of 25-34 year olds is a negative influence on stock prices. That has been true in Japan (with their entirely different age distribution) and in the U.S. in the past (see Encyclopedia, chart V29l, for a chart overlaying the Saver/Spender Ratio on the constant dollar DJIA from 1900 to 2050).
Why Doesn't all the Spending Strengthen the Economy?
First, because they don't spend that much. 35 to 44 year olds, 45 to 54 year olds and even 55-64 year olds spend more per capita. Second, because they are big borrowers.
This age group (25 to 34-year-olds) certainly spends almost all of their income. In fact, they typically incur a large debt load at this age. That's why Stan Salvigsen used them as "Yuppies" in his Yuppie/Nerd ratio (25 to 34-year-olds divided by 45 to 54-year-olds). As the number of Yuppies increases, their borrowing puts upward pressure on interest rates. Nerds, on the other hand, have the highest per capita income (half again what Yuppies earn), and more importantly, have the highest per capita net savings (roughly double that of 35 to 44-year-olds or of 55 to 64 year-olds, and over five times that of Yuppies). Those savings add money to the pool of bids for all financial assets, not just the bond market. Historically, savers approaching retirement tend to become more risk averse, and to focus their incremental savings on bonds, increasing their influence on interest rates. That's why the Yuppie/Nerd ratio is such a good long-term forecaster of interest rates (see Encyclopedia, chart V29j, for a chart overlaying Moody's Aaa Bond Yields and the Yuppie/Nerd ratio from 1900 to 2050).
Borrowing by 25 to 34-year-olds adds supply to the bond market, draining money from all financial assets. Our research has shown that while 45 to 54-year-olds affect the demand for bonds, 40 to 49-year-olds have more of an effect on the demand for stocks. We first noticed this in the Japanese numbers, and were quite pleased to see that it also worked for the U.S. stock market.
"Original thought is
like original sin: both happened before you were born to people you could not have
This piece would not have been possible without the assistance of Jim Bianco and Ian McAvity, for which I am very grateful.
Like any succesful team, Topline Investment Graphics has great players. I would not have been able to write this piece without the invaluable assistance and encouragement of Ron Griess, Donna Baden and my loving wife, Susan.
John Carder, CMT
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